Artesian: Underfollowed Water Play

Electric utilities are contending with disruptive technologies that promise to transform their business. By contrast, water utilities deliver an essential service whose mode of operation is unlikely to be disrupted anytime soon, explains Ari Charney, editor of Income without Borders.

That's why water utilities trade at such high valuations. And while income investors love water stocks, the average yield among this cohort is just 2.3% compared to 3.4% for the average electric utility.

But there is one tiny water utility that offers an attractive yield and one of the lowest relative valuations among its peers.

Delaware-based Artesian Resources (ARTNA) has a market cap of just $256 million, making it by far the smallest regulated water utility that's listed on the market. As such, it isn't widely followed on Wall Street.

That may be one of the reasons why the stock has fallen so hard since water utilities hit a high in early July. Shares of Artesian are down 20.6% and currently trade at a P/E of 22.0, not cheap compared to the market but a relative value compared to its peers.

In early August, Artesian reported earnings that missed analyst estimates by 3.0% on the top line and 10.2% on the bottom line. Management attributed the 8% year-over-year decline in earnings to lower water consumption due to cooler and wetter weather.

That brings us to the biggest risk -- its limited operating geography. Artesian's water and wastewater operations are concentrated in Delaware and nearby parts of Maryland and Pennsylvania.

With Delaware accounting for 90% of revenue, that means the company's fortunes are largely tied to a single state's regulators.

Fortunately, regulatory relations appear to be largely constructive. In addition, Artesian is permitted to increase rates temporarily while a rate case is proceeding.

This eliminates the effect of regulatory lag, though it can lead to customer reimbursements if regulators decide on a lower rate than the one the firm requested.

Regulatory whims aren't the only risk of Artesian's small footprint. As second-quarter results showed, the company is significantly exposed to weather in just one region, which can also weigh on earnings.

Nevertheless, earnings per share are projected to grow 3% for full-year 2016 and 11% in 2017.

Artesian has raised its dividend for 20 consecutive years. Over the trailing five-year period, the company has increased its dividend by 3.3% annually, for a quarterly payout that totals $0.91 annually and a forward yield of 3.3%.

Yield chasers might scoff at Artesian's yield, but it's a full percentage point higher than its peers, though its payout ratio is on the higher side, at around 70%.